“A Random Walk Down Wall Street” is one of the important books on investing written by Burton Gordon Malkiel. Through this book, Malkiel popularized the concept of the Random Walk Hypothesis. The book states that one cannot consistently beat the market average return through active portfolio management since stock prices resemble the random walk which is impossible to predict. Whether through fundamental analysis or technical analysis, an investor/trader cannot achieve a superior return than the index. Due to factors such as taxation, commission, or other costs, the return from active trading will be inferior to those achieved through the index (passive) investing.
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Here, we have compiled some of the important excerpts from the book. Hope it is useful.
Important Excerpts From The Book ‘A Random Walk Down On Wall Street’
Human nature likes order; people find it hard to accept the notion of randomness. No matter what the laws of chance might tell us, we search for patterns among random events wherever they might occur- not only in the stock market but even in interpreting sporting phenomena.
The lessons of market history are clear. Styles and fashions in investors’ evaluations of securities can and often do play a critical role in the pricing of securities. The stock market at times conforms well to the castle-in-the-air theory. For this reason, the game of investing can be extremely dangerous.
Historically, the stock market is like a gambling casino with the odds in your favor. Over the long pull, stocks are given something like nine and a half to ten percent compounded per year. The banks have probably given you something in the order of four to five.
I view investing as a method of purchasing assets to gain profit in the form of reasonably predictable income (dividends, interest, or rentals) and appreciation over the long term.
There is always some combination of growth rate and growth period that will produce any specific price. In this sense, it is intrinsically impossible, given human nature, to calculate the intrinsic value of a share.
For many of us, trying to outguess the market is a game that is much too much fun to give up. Even if you were convinced you would not do any better than average, I’m sure that most of you with speculative temperaments would still want to keep on playing the game of selecting individual stocks with at least some portion of the money you invest.
Put time on your side. Start saving early and save regularly. Live modestly and don’t touch the money that’s been set aside.
There are four factors that create irrational market behavior: overconfidence, biased judgments, herd mentality, and loss aversion.
Index funds are tax-friendly, allowing investors to defer the realization of capital gains or avoid them completely if the shares are later bequeathed. To the extent that the long-run uptrend in stock prices continues, switching from security to security involves realizing capital gains that are subject to tax. Taxes are a crucially important financial consideration because the earlier realization of capital gains will substantially reduce net returns.
The decision not to sell is exactly the same as the decision to buy the stock at the current price.
Look for growth situations with low price-earnings multiples. If the growth takes place, there’s often a double bonus—both the earnings and the multiple rise, producing large gains. Beware of very high multiple stocks in which future growth is already discounted. If growth doesn’t materialize, losses are doubly heavy—both the earnings and the multiples drop.
Common sense attests that some people can and do beat the market. It’s not all chance. Many academics agree; but the method of beating the market, they say, is not to exercise superior clairvoyance but rather to assume greater risk. Risk, and risk alone, determines the degree to which returns will be above or below average.
I have become increasingly convinced that the past records of mutual fund managers are essentially worthless in predicting future success. The few examples of consistently superior performance occur no more frequently than can be expected by chance.
A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.
One’s capacity for risk-bearing depends importantly upon one’s age and ability to earn income from noninvestment sources.
J.P. Morgan once had a friend who was so worried about the stock holdings that he could not sleep at night. The friend asked, ‘What should I do about my stocks?’ Morgan replied, ‘Sell down to your sleeping point’ Every investor must decide the trade-off he or she is willing to make between eating well and sleeping well. High investment rewards can only be achieved at the cost of substantial risk-taking.
Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.
It is the definition of the time period for the investment return and the predictability of the returns that often distinguish investment from speculation. A speculator buys stocks hoping for a short-term gain over the next days or weeks. An investor buys stocks likely to produce a dependable future stream of cash returns and capital gains when measured over years or decades.
It is not hard to make money in the market. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges. It is an obvious lesson, but one frequently ignored.